A firm issues six-month commercial paper with a $1 million face value and receives $970,000.What is the EAR the firm is paying for these funds?

Question

Quizplus · Accepted Answer

The EAR (Effective Annual Rate) can be calculated using the formula for EAR when the interest is compounded semi-annually: EAR = (1 + i/n)^(n*1) - 1, where i is the interest rate per period and n is the number of periods per year. In this case, the firm receives $970,000 for a paper with a face value of $1,000,000, meaning it effectively pays $30,000 in interest over six months. The semi-annual interest rate is $30,000/$970,000 = 0.0309278 or 3.09278%. To annualize this semi-annually compounded rate: EAR = (1 + 0.0309278)^(2) - 1 = 0.0628 or 6.28%.

A Firm Issues Six-Month Commercial Paper with a $1 Million